DEFICIT ISSUES

 
 
The federal government's promise to extricate the U.S. economy from this recession involves more spending (increasing public debt) and more subsidies for consumers, such as car rebates and home buying incentives (more private debt). In other words, more debt is supposed to solve the problem of over-indebtedness. The truth is that this policy merely indentures its citizens further without providing any income for repayment of debt. In previous letters we have discussed the fact that the government spending multiplier is zero (read Professor Robert Barro's book, Macroeconomics - a Modern Approach, p. 370).
This means there is no long term income benefit from stimulus programs. According to the latest academic research, the most recent $800 billion stimulus plan will boost economic activity in the short run, but will surely depress economic activity over time. The government problem is complicated by the fact that the tax multiplier is 3, meaning that a 1% change in taxes will change GDP by about 3% over time. More recent research (Barro & Redlick, September 2009,"NBER Working Paper 15369"suggests that a 1% cut in the marginal tax rate would raise GDP in the ensuing year by 0.6%. With the deficit rising due to a zero spending multiplier, the tendency will be to try to raise taxes to pay for this higher level of expenditures, which will further depress aggregate spending and output.

BLACK MOOD

I am in a particularly black mood today. Not sure exactly why but of course the market behaviour is a likely cause. It is probably because I feel boxed in with this incredibly stupid emotional why of thinking driving the markets at present. The top has got to be close.

DONE THIS BEFORE

Catching a major TOP always is a case of hope followed by despair over and over again, and then it happens before you know it almost when it feels impossible to work in your favour.

HOMEBUILDER HEAD & SHOULDERS

PSYCHOLOGICAL TIPS FOR TRADERS

I thought this was a good practical tip. The author is a psychologist who is part of a hedge fund team run by a psychiatrist.

 

Here are some potential indicators of changing market patterns:

Psychological:


-Unusual Emotions in yourself such as exuberance, fear or cockiness
-Emotions in other traders you talk to such as exuberance, fear or cockiness
-Overwhelming consensus of where the market is going
-Physiological changes in yourself such as stomach pain, tenseness, funny taste in your mouth, back ache etc.
-Emotions in the news and headlines

Market Indicators:


-Volume
-Daily Range
-Volatility and implied volatility in options
-Momentum
-Size of trades or unusual large orders
-New chart patterns
-Unexpected price moves
-Time of day pattern shfits
-Opening market patterns changes
-Closing market pattern changes
-Changes in your ability to execute trades
-Changes in your P&L patterns
-Unusual price gaps
-Sudden quiet
-Shifts in how the market reacts to newsChanging margin requirements

Remember, all trading systems work during certain market periods. All trading systems eventually fail. It’s the law. If you can free yourself from the belief in your system as the holy grail, you can see new patterns as they emerge and profit.

Easy to say, but how do you see new patterns? In my coaching practice we create a series of Mind Muscles™. These are neurological circuits that help us create new responses to market conditions. Creating concrete visualizations is one way of building new Mind Muscles™ and behavioral responses. If you want to create a Mind Muscle™ for new pattern recognition try this exercise.

First, get comfortable in a place that you won’t be interrupted. Take a moment do some deep breathing exercises. One exercise that works well is to slow count to three on your inhale through your nose. Hold the inhale for another count of three. Exhale through your mouth to a slow count of three and rest at full exhalation for another count of three. Repeat 10 times or until you feel your body settling in.

Then close your eyes and imagine a dog, a well trained bloodhound. He is sniffing the air, the ground and various objects. Imagine this hound dog in detail, his colors, movements and sounds. He is looking for some scent that is out of the ordinary. Spend some time with him as he sniffs his world. Now give him a name. Sniffer works great if nothing else comes to mind. Call the dog to your side. Pet him and give him some love. Then tell him to go and sniff out new patterns and to bay at the top of his voice when he finds one. Call him back, reward him with love, and send him out again.

Now, when you are trading and have a moment, visualize your new bloodhound. He represents a new behavior you have created in your brain. Call him by name. Give him some love. Tell him to go sniff out pattern changes. Watch him as he sniffs both psychological indicators and market metrics. And wait for the baying to begin.

For more on the how and why of creating Mind Muscles™ please call.

Richard Friesen
RFriesen@MarketPsych.com

FIBONACCI FANS & RETRACEMENT MAY BE SIGNIFICANT

 

BRITISH LAND

 

GANN & ARC's MAY HAVE A POINT

 

This is It

I have this strange inner calm. The market has become completely
behavioural. The market is chasing BIG numbers on the indexes. 10000
on the Dow. 5000 on the Asx. We r topping out.

Stay the course

Sent from my iPhone

Am I Clutching at Straws

My Wedge I am not sure if it meets with strict EW rules and guidelines.

It is a less than perfect way of counting 5 down. We are at a significant retracement mark (61.8%) so we should expect a weak opening.

DOES THIS COUNT WORK

If so then the high is in. Big GAP opening higher on the cash before coming down.

 

HOLDING OUT

our time is almost here.

TIME WARP

I have just got out of the bath having read the latest BRW - YOUNG list of 200 of Australian's wealthiest below 40's. I haven't read something this bullish and upbeat in close on 3 years.

There is an air of invincibility to the articles that has my mouth wide open. If this is not a case of hubris to far then I don't know what is. If I am correct in my assessment of where the market is likely to take us. The latest BRW edition will rank as one of the great specimens of reaching a step too far.

Can someone please tell these guys that we are amidst the greatest financial crisis in 75 years, and perhaps the biggest ever.

(Note to myself, place an order for next years edition it should make for sombre reading)

IT DOESNT HURT AS MUCH

An interesting insight into personal investment psychology.

 

I have just missed the biggest up move in half a century, and it has happened in the space of about 6 months. In theory as a fund manager I should be absolutely gutted, yet I really am not. Yes I am hurting because I have been trying to short the market into the oncoming steam train so that hasn’t been nice but that is more about the pain that comes from being early in a trade, not the missed trade that so often hurts like hell.

 

I think it is vitally important to first look at the prelude to this rampant market, the runaway market comes on the back of a “once in a century” (we know that in reality they happen more often than the statistics would have us believe) bear market that in many instances dropped indexes 70% top to bottom. The rally of 50% plus has to be seen in the context of a market slaughter. We remain in many instances below 50% of the previous highs so whilst there would have been a fantastic story to tell if one had been short at the top and long at the bottom, being short at the top still remains the most profitable trade, even after having to suck the wind of this foul smelling bull.

 

There is a further level of context to be brought to the proverbial butchers table; if you are one for investing with higher probability odds of success then turning bullish over the last 3 – 4 months is simply like a lamb going on a jog through an abboitir. It was only in March of this year that the world’s financial system was technically insolvent, and even today I argue the system is technically insolvent, there is no way of responsibly repaying all this debt backed by inflated assets on corporate balance sheets. There is only the hope of governments being able to borrow money from equally suspicious governments and structurally flawed institutional investors (who “have to” put a pre-described amount of money to work). There is only so much the central banks can do by way of stimulus before eroding the purchase power of their currency so all that remains is the hope of a miracle or the inevitable doing the hard yards.

 

What has changed in terms of fixing the ills that got us into this proverbial mess; I would argue in terms of actions taken nothing. However, the system has delivered its own changes and that has been the reduction in credit growth. Once again this isn’t because banks or other shadowy banks wanted to lend less, on the contrary they have tried everything in their power to try and lend as much as before the only difference is the level of confidence in the system has lowered the level of credit available in the system as the margins required for this increased level of distrust has lowered how much the system/multiplier can “juice”.

 

So coming back to my original statement of the fact that it doesn’t hurt as much, the reason is because there is solid rational ground for having sidestepped this bull market in favour of better risk rewards. Does this mean I would have done everything the same, of course not. We always live and learn, but I can state for sure that I have absolutely no regret for not getting firmly behind this bounce; which after all may turn into a dead-cat with no more lives.

 

 

SANITY WILL PREVAIL

Real Estate Watch:

October 7 – Wall Street Journal (Lingling Wei and Maurice Tamman):  “Banks in the U.S. ‘are slow’ to take losses on their commercial real-estate loans being battered by slumping property values and rental payments, according to a Federal Reserve presentation… The remarks suggest that banking regulators are girding for a rerun of the housing-related losses now slamming thousands of banks that failed to set aside enough capital during the boom to cushion themselves when the bubble burst. ‘Banks will be slow to recognize the severity of the loss -- just as they were in residential,’ according to the Fed…”

October 8 – Bloomberg (Daniel Taub):  “U.S. home sellers cut their asking prices by a total of $28.4 billion… Trulia Inc. said.   The average discount was 10% as of Oct. 1… Homes listed for more than $2 million were cut the most, with owners taking an average of 14% off the original price. Luxury homes accounted for 25% of all of the reductions.” 

October 8 – Bloomberg (Daniel Taub):  “Vacancies at U.S. shopping centers rose in the third quarter to a 17-year high as unemployment climbed, consumers cut spending and stores closed…Reis Inc. said.  Vacancies at neighborhood and community shopping centers increased to 10.3%, the highest level since 1992, from 8.4% a year earlier…” 

October 7 – Wall Street Journal (Christina S.N. Lewis):  “Rent for office space is falling at the fastest pace in more than a decade as vacancies create a glut and landlords slash prices to attract tenants. Nationwide, effective office rents fell 8.5% in the third quarter compared with the same period a year ago… according to Reis Inc…” 

October 6 – Bloomberg (Hui-yong Yu):  “U.S. apartment vacancies rose to 7.8% in the third quarter, the highest since 1986… Reis Inc. said.  Actual rents paid by tenants, known as effective rents, declined 2.7% from a year earlier… Asking rents, or what landlords sought, fell 1.8% from a year earlier.” 

 

RESEARCH INDEPENDENCE

‘Sell’ for Research Renegades Becomes Business Off Wall Street 

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By Edward Robinson

Oct. 9 (Bloomberg) -- When Credit Suisse Group analyst Ivy Zelman refused to turn bullish on homebuilding stocks during a rally in the fourth quarter of 2006, the blowback was intense.

She says investors told her that some housing industry executives were ridiculing her analysis as a “jihad,” and several of the bank’s sales representatives pressed her to upgrade “hold” ratings to “buys” on companies to appease bullish institutional-investor clients. One sales manager even sent her an e-mail warning that analysts who stayed bearish too long often lost their jobs.

Zelman was furious. She’d spent 16 years dissecting the home construction business and wasn’t about to ditch her analysis and join the bulls’ party. On Dec. 7, 2006, she slapped a “sell” call on the entire group, and during the next 12 months, the Standard & Poor’s Supercomposite Homebuilding Index plunged 53 percent as the real estate market collapsed.

Stefano Natella, Credit Suisse’s global head of equity research, says that while debate between the sales team and research staff over their calls is normal and healthy, the e- mail from the manager crossed the line and he was reprimanded. Even though Zelman had Natella’s support, she grew fed up with a culture that prized irrational exuberance over sober analysis.

“It was no fun being the bear,” Zelman, 43, says. “I’d come home from work and just be so upset. So I started thinking, ‘If I believe in my work, why not do it on my own?’”

Going Solo

In May 2007, she resigned from Credit Suisse. After weighing whether to start a hedge fund, a buyout boutique or a research firm, she settled on the latter and opened Zelman & Associates, in Cleveland and New York, five months later.

Zelman is one of a rising number of equity analysts who’ve quit large banks and gone solo. They’re joining a wave of investment bankers and traders who’ve moved off Wall Street to set up mergers and acquisitions advisory firms and work at mid- size brokerages as the financial world reconstitutes after the credit crackup.

Independent research firms are popping up in New York, Silicon Valley and London, where Stuart Graham, the former head of Merrill Lynch & Co.’s European banking stocks team, unveiled Autonomous Research LLP in July with the motto “Free from external control and constraint.” The number of independent research firms in the U.S. has soared to 2,667 from 1,012 in 2006, according to Integrity Research Associates LLC., a New York-based consulting firm.

Outflanking Wall Street

Zelman and her fellow independents are taking aim at Wall Street banks by selling research to institutional investors, ranging from PNC Capital Advisors Inc., an investment firm in Philadelphia, to hedge fund firms such as Passport Capital LLC in San Francisco and Vardon Capital Management LLC in New York.

Independent shops will have a hard time outflanking resurgent securities firms, which possess huge advantages. Their underwriting and allocation of equity offerings motivates money managers to preserve their relationships with brokerages, says Jay Bennett, a consultant with Greenwich Associates, a Stamford, Connecticut-based firm that advises institutional investors.

Today, Bank of America Corp., JPMorgan Chase & Co. and other giant securities firms receive almost 70 percent of the commissions institutional investors dole out for research. That compares with 3 percent for independents and the rest for mid- size firms, according to Greenwich.

“There is a symbiotic relationship between the bulge- bracket bank and the typical institutional investor, and I can’t see that being displaced,” Bennett says.

Analysts Marginalized

In 2002, then-New York Attorney General Eliot Spitzer and the Securities and Exchange Commission began investigating the research industry in the midst of conflict of interest scandals that erupted after the dot-com bubble imploded in 2000. Rock star analysts like Jack Grubman, the telecom specialist at Citigroup Inc. who earned $67 million from 1999 to 2002, and Henry Blodget, Merrill Lynch’s dot-com guru, had issued glowing recommendations of companies to win investment banking business, according to lawsuits filed by the SEC.

In 2003, the SEC prohibited the analysts for life from associating with a broker-dealer or investment adviser. Grubman and Blodget didn’t admit or deny wrongdoing in their settlements.

In 2003, Spitzer and the SEC struck a settlement with Goldman Sachs Group Inc., Merrill and eight other major banks that permanently barred them from using investment banking revenue to compensate research staffs and fund their work. Analysts became marginalized on Wall Street, losing thousands of jobs and their seven-figure salaries: Annual pay for top performers fell to about $600,000 by 2008 from a peak of $2.5 million in 2000, says Alan Johnson, president of Johnson Associates Inc., a New York-based compensation consultant.

Curbing Excesses

“The analysts that were good stock pickers all went to hedge funds,” says Steven Purvis, a money manager at Fort Worth, Texas-based Luther King Capital Management Inc., which oversees $6 billion.

The settlement did curb many of the excesses of the Internet era, says Robert Olstein, chairman of Olstein Capital Management LP, a mutual fund firm in Purchase, New York. Money managers continue to plumb Wall Street research for valuable information on companies and markets their own internal analysts may lack, says A. Michael Lipper, a director at the New York Society of Security Analysts, a professional organization.

Rare ‘Sell’ Calls

In the fourth quarter of 2008, Betsy Graseck at Morgan Stanley recommended investors sell shares in Bank of America after concluding its credit card business and takeover of Countrywide Financial Corp. would saddle it with huge losses. Nineteen of the 21 analysts who covered Bank of America at that time had “buy” and “hold” calls on its stock, which nose-dived 80 percent from Sept. 30, 2008, to March 31, according to data compiled by Bloomberg.

“Some money managers may deride the research, but I know demand for it at institutions is high,” says Lipper, the founder of Lipper Advisory Services Inc., a Summit, New Jersey-based firm that consults for foundations and pension funds.

Calls like Graseck’s are not common in a Wall Street research system that continues to promote rampant bullishness, according to studies by Jill Fisch, a business law professor at the University of Pennsylvania in Philadelphia. In October 2008, as the global financial system teetered on the brink of collapse, “sell” calls in U.S. markets constituted 6 percent of the total recommendations by analysts, with “buys” comprising 36 percent and “holds,” 58 percent, according to Bloomberg data.

‘Conflict-Free Research’

Almost a year later, amid a stock market rally, the percentage of “buy” calls dropped: They made up 32 percent, with “holds” comprising 63 percent and “sells,” 5 percent, as of Oct. 8.

Money managers are concerned that proprietary trading desks at the largest securities firms are benefiting from research reports at the expense of clients. On Aug. 25,William Galvin, Massachusetts’s top financial regulator, subpoenaed Goldman Sachs for information on possible weekly “trading huddles” between its analysts, traders and investors.

Galvin wants to know whether Goldman’s analysts previewed imminent changes in their stock recommendations for select clients and whether Goldman traded on these tips for its own account before disseminating the information.

“We don’t like hearing stories about possible front-running or preferential treatment of some clients over others,” says Jonathan Boersma, director of practice standards at the CFA Centre for Financial Market Integrity in Charlottesville, Virginia. “Investors want conflict-free research.”

Break From the Pack

Goldman spokesman Ed Canaday says the bank doesn’t comment on regulatory matters. Authorities haven’t accused Goldman of wrongdoing.

Independent analysts are trying to win clients with calls that break from the pack. In January, Dana Telsey, founder of Telsey Advisory Group in New York and the former head of retail, apparel and luxury goods research at Bear Stearns & Co., made J. Crew Group Inc. a top pick for the year. Telsey was one of 3 analysts out of 20 who cover the New York-based retailer to favor the stock at that time. By Oct 8, it had skyrocketed 208 percent.

On March 23, Keith McCullough, founder and chief executive officer of Research Edge LLC in New Haven, Connecticut, urged clients to buy San Rafael, California-based software maker Autodesk Inc. Only 4 of the 17 analysts who cover Autodesk had “buys” on the shares, which spiked 64 percent through Oct. 8.

Independents Misfire

“Independent research is much cleaner,” says Douglas Famigletti, a money manager at New York-based Griffin Asset Management Inc., which oversees $415 million. “They aren’t conflicted, and they can write whatever they want about a stock. Of course, that means nothing if their ideas aren’t any good.”

The independents do misfire. On April 8, Zelman downgraded D.R. Horton Inc., a Fort Worth-based homebuilder, to “sell” after seeing it trade at 1.60 times its adjusted book value compared with the industry’s median valuation of 1.32. D.R. Horton rallied 18 percent through Oct. 8 on renewed momentum in homebuilding stocks.

And McCullough, a macroeconomic analyst who covers stocks, commodities and emerging markets, got stung in May by advising investors to short the India Fund, which includes equities traded on the Bombay Stock Exchange. The ruling Congress Party’s landslide victory in elections that concluded on May 13 triggered a 43 percent surge in the fund’s shares that month. In a short sale, an investor borrows and sells a security in the hope its price will drop before he has to buy it back.

Main Street Left Behind

Hedge funds are spurring much of the demand for independent research, says Sanford Bragg, president of Integrity Research Associates. After a record 1,471 hedge funds closed in 2008, the survivors in the $1.4 trillion industry are under pressure to deliver gains to their clients, and that’s stoking demand for innovative analysis.

“There is a flourishing alternative research marketplace, but it’s driven by hedge funds,” Bragg says. “It’s invisible to retail investors.”

Main street is being left behind. The Spitzer settlement tried to spur an independent research industry for retail investors by requiring the 10 participating banks to spend a total of $432.5 million on alternative analysis and offer it to their clients for free. In the next six years, Bragg says, the banks found very few takers for the independent research because most investors continued to trust their brokers or didn’t know it was available.

No Exclusivity

“It’s hard to argue the settlement had any lasting impact,” Bragg says.

Independent research appeals to hedge funds partly because of its limited distribution. Stock research is widely disseminated through e-mails, Web sites and published reports. Gabe Birdsall, a portfolio manager at Brasada Capital Management, a Houston hedge fund firm, says he’s inundated with more than 400 e-mails a day, much of it securities reports.

“The problem with research is everybody is getting the same stuff; there’s no exclusivity,” says Penny Herscher, CEO of FirstRain Inc., a San Mateo, California-based company that developed a search engine hedge fund managers use to prowl the Web for obscure market and company data. “There is enormous interest at hedge funds to control their own information.”

Exclusivity doesn’t come cheap. Many independent firms have about 100 clients and charge them $15,000 to more than $100,000 a year. They receive a basic subscription to reports and newsletters, and for additional fees, clients get the right to talk to analysts one-on-one and attend conferences where they can meet with company executives.

Shrinking Industry

In September, Zelman hosted a three-day conference at the Four Seasons Resort & Club near Dallas where about 350 guests including clients tried to glean insights from the CEOs of KB Home, Pulte Homes Inc. and others.

The proliferation of research firms in the past few years will make it harder for them to survive, says Scott Cleland, a former telecommunications analyst who closed his own firm in 2005 after concluding he was in a shrinking industry. Cleland says there’s an oversupply of analysis, which is bound to push down the prices the independents can charge. On Oct. 6, Integrity Research reported that 11 independent firms had disbanded in recent months.

“If the independents analyze their own business the way they analyze the industries they cover, they’ll conclude what I did: The business is increasingly not viable,” says Cleland, who now runs a Washington-based telecom consulting firm called Precursor LLC.

‘Control My Own Destiny’

Many independent analysts are happy to swap the market power of their former employers for their newfound freedom. Edward Wolfe, who built Bear Stearns’s transportation research team, became exasperated with how disastrous decisions made by colleagues in other parts of the firm hurt his group. In late 2007, Bear’s massive losses on subprime mortgages drove its shares from a high of $171.51 in January 2007 to $4.81 in March 2008, obliterating the deferred compensation that accounted for up to 50 percent of Wolfe’s pay.

“Our team was having a great year, but because of issues in mortgages, our compensation was impacted, and that really got to me,” Wolfe says. “I want to be in control of my own destiny and the revenue I generate.” After JPMorgan absorbed Bear in March 2008, he quit and opened his own firm, Wolfe Research LLC, in New York one month later.

Zelman, the credit Suisse analyst, had little idea how difficult running her own shop would be. There are clients to advise, new customers to win and a never-ending stream of research to distribute.

A Frenetic Pace

While she’s delegated some chores -- President David Zelman, her husband, manages day-to-day activities and client relations, and Director of Research Dennis McGill, a former Credit Suisse colleague who helped Zelman set up her firm, oversees the analysis process -- Ivy is still preoccupied with making sure all the parts of her 15-employee company perform.

“You worry about the client that’s not paying you and the salespeople who may not be doing their jobs, and at Credit Suisse, you didn’t have to worry about that,” she says. “You underestimate how much of your personal life you have to give up.”

Ivy and David, 46, a former Salomon Brothers Inc. institutional salesman, share an office suite in a three-story corporate park in suburban Cleveland. It’s decorated with their youngest child’s finger paintings, and sometimes their three kids, ages 4 to 9, visit after school.

Even in Cleveland, where the couple moved to be closer to David’s family, Ivy retains a New York look -- black blouse and black slacks -- and a frenetic pace. Phones are ringing nonstop on July 28 as Zelman analyzes just-released data: New-home sales in June jumped the most in eight years, and property values look to be stabilizing.

Mounting Foreclosures

Many of her clients are clamoring to know whether the market has hit bottom. In terms of prices, she says probably not: One out of three owners has a mortgage worth more than the value of the home, and mounting foreclosures and distressed properties are slated to account for 53 percent of home sales in 2010 compared with 40 percent in 2008, according to Moody’s.

“When that inventory hits the market, it’s going to undermine prices,” she says.

Zelman eyeballs the shares of Masco Corp., a Taylor, Michigan-based manufacturer of home improvement products, and sees they’ve jumped 8 percent off their opening price of $12.13.

“If anyone asks, just say we think the stock has gotten a little ahead of itself,” Ivy calls across the room to David. He nods, phone in hand, and passes the word to a client.

Private Network

Zelman relies on her own network of almost 1,000 private homebuilders, mortgage bankers and even drywall distributors to provide intelligence about the housing market. Under a barter arrangement, the contacts agree not to talk to other analysts in exchange for her research.

Every month, Zelman surveys her sources, asking about demand for their products and the forces spurring or curbing it. The data form the basis of her analysis, and encrypted reports are available to clients on her Web site.

Hedge fund managers use Zelman’s reports to see where the housing market may be headed and as a check on months-old housing data that drive investor assumptions. As early as July 2005, she alerted clients to the coming mortgage crash in a report called “Investors Gone Wild.”

“You’re going to find out what’s going on from her network long before you get it from the sell-side and publicly released data,” says Ryan Randall, an analyst at Passport Capital, a Zelman client and $2.1 billion hedge fund firm.

Premature Rally

Investors buoyed by positive housing data bid up the S&P homebuilding index 43 percent from June 30 to Aug. 28. Zelman learned from her network that the $8,000 federal tax credit for first-time home buyers passed in President Barack Obama’sstimulus package was fueling demand and speculative construction. And as banks continue to disgorge foreclosed properties into the marketplace, a supply glut could wallop homebuilding stocks yet again.

“The rally may be premature,” she says.

So on July 13, Zelman advised clients to exploit the short- term jumps in some homebuilding stocks while recognizing that the surge might end soon. She upgraded M/I Homes Inc., a Columbus, Ohio-based homebuilder, to a “buy,” and shares rose 55 percent to $13.13 during the next 14 trading days. Zelman cut M/I Homes to “hold” on July 31 after it hit her price target. The stock climbed another 12 percent by Oct. 8

“Ivy’s a little too bearish on our industry right now,” says Robert Schottenstein, M/I Homes’ CEO. “But she understands what it takes to make money in this business, and I have a great deal of respect for her.”

Rapidly Expanding

Zelman, who put herself through night school at George Mason University in Virginia and earned a bachelor’s degree in accounting, plans to push her firm beyond the 20 homebuilding stocks she covers to draw new clients.

She will initiate coverage of Home Depot Inc. and Lowe’s Cos. by the end of the year. Zelman says her firm makes a profit, and true to form, she’s cautious about overreaching.

“I don’t want to be in a situation where I hire five analysts and all of sudden they’re making calls I disagree with,” she says. “There’s no rush.”

By contrast, Telsey, the retail analyst from Bear Stearns, is rapidly expanding the firm she opened in February 2006 on Fifth Avenue, New York’s luxury apparel mecca. Its 46 employees occupy a hive of glass-walled offices with polished-stone floors. In a bullpen of cubicles, a half dozen analysts scrutinize stocks in nine consumer-related industries for clients, including PNC Capital Advisors.

‘Market Share Counts’

Telsey, 46, in a corner office cluttered with black shopping bags from Barneys New York and stacks of financial reports, says she’s hiring analysts and pushing coverage into cosmetics, footwear makers and drugstores.

“Market share counts,” Telsey says. “We didn’t get into this venture to be small.”

Telsey, a Manhattan native with a Master of Business Administration from Fordham University, joined Bear in 1994. Twelve years later, she was running its 18-member retail research team. She grew frustrated at her inability to promote her people and award bonuses -- decisions made by management committees -- and watched as rivals, especially hedge funds, raided her ranks.

“The bulge brackets provide an entry point for people to get into the research business, but they weren’t making careers there anymore,” Telsey says. “I wanted to do my own thing where analysts could practice the craft of research as a career.”

Tough First Year

The first year was rough, says Arnold Kanarick, Telsey Advisory’s executive vice president and Bear’s former human resources head. About two-thirds of the money managers they solicited balked out of concern Telsey’s work would falter and she would lose access to CEOs. She had to invest more than $1 million of her own capital in a sales staff and analysts in the hope business would come.

“Some independents will not be successful because they’re undercapitalized, and clients will hesitate to sign up because they’re not sure they’re going to survive,” Kanarick says. “We say that with the voice of experience.”

Telsey, who favors black Italian pantsuits and Prada pumps, plowed ahead with her research. She tours malls across the country to see how merchandise is selling at the companies she covers and which stores are staging their wares creatively to boost sales.

“Retail is entertainment,” says Telsey on Aug. 31 over the pulsating club music in anAmerican Eagle Outfitters Inc. clothing store in San Francisco. She flashes a smile at the salesclerks and peppers them with questions.

Top Pick

“Are you working more hours or less in the last month?” Telsey asks a clerk.

“Last week, we all had a lot of hours,” the clerk replies. Sales are probably up at this store, Telsey says.

Her shoe-leather research paid off this year, helping her select Gap Inc. as a “top pick” for 2009 in an outlook she sent clients in January. Telsey doesn’t issue “buys” or “sells,” preferring to set price targets because that’s how money managers select stocks.

She said the San Francisco-based retailer’s struggle to rebound from years of falling sales had left it with $1.6 billion in cash, no long-term debt and a winning back-to-basics lineup of jeans, plaid shirts and chinos. Gap shares soared 69 percent through Oct. 8.

Flashing Green Orbs

In the same outlook, Telsey missed on Wal-Mart Stores Inc. She predicted the stock, which returned 18 percent in 2008, would continue its run in the first half of 2009 as the retailer pulled cost-conscious consumers from Target Stores Inc. Instead, investors pulled back in anticipation that the economy would recover and Walmart’s shares fell 15 percent by June 30.

“Walmart was last year’s stock,” she says.

Telsey says she’s turning a profit, winning over about a third of the institutional investors that were reluctant to hire her in 2006.

“There are still a lot of good analysts at the bulge brackets, so it comes down to what are you doing that’s going to differentiate you from your competitors,” Telsey says.

When McCullough, the macroeconomic analyst, formed Research Edge in April 2008, he was intent on upending the way analysis is delivered to investors. His pitch to clients is transparency.

McCullough, a former hedge fund manager at Carlyle Group, makes pretend bets based on his team’s stock recommendations, and clients can view the outcome of each one of his 650 phantom investments on the Research Edge Web site. He places flashing green orbs next to tickers he’s buying and red lights by stocks he’s shorting. By running his firm like a virtual hedge fund, he shows clients how his analysis performs.

‘Show Wins and Losses’

“The research game is broken,” McCullough, 34, says. “We’re just showing our clients what they normally don’t see. If you want to be in the game, you have to show your wins and losses.”

On Sept. 16, McCullough put Apple Inc.’s ticker on the site with a red light. He advised clients to short the tech juggernaut at $182.55 a share, a 52-week high, after Jim Cramer, the CNBC investing personality, recommended it.

“Cramer was pumping it last night,” McCullough wrote in a note.

He believed the commentator was wrong and Apple would fall. On Sept. 21, the analyst covered his short bet on Apple at $182.30 for a 0.14 percent return.

“It’s nice to be able to go back and see if his analysis has panned out,” says Birdsall of Brasada Capital Management, a $50 million hedge fund firm founded in January.

A Trader’s Metabolism

Research Edge’s seven analysts work in the former mansion of William Howard Taft, the U.S. president from 1909 to 1913, on the edge of the Yale University campus. They cover a hodgepodge of industries: Rebecca Runkle, a former Morgan Stanley technology analyst, researches software and computers, and Brian McGough, another Morgan Stanley alum, analyzes apparel and footwear. Their colleagues study health care, casinos and gaming, and emerging markets.

McCullough, with an undergraduate degree in economics from Yale, says his firm is profitable. He has more than 100 institutional clients who pay $30,000 to $100,000 a year for his firm’s research and access to its analysts. Individual investors who want to see the virtual portfolio and a limited amount of research pay $400 a month.

McCullough, a native of Thunder Bay, Ontario, and former captain of the Yale varsity hockey team, has the metabolism and gung-ho nature of a trader.

“I had the most penalty minutes on the team in my sophomore year,” says McCullough, who had to replace two of his front teeth after they were knocked out on the ice.

China Correction

He gets up almost every morning at 4 a.m. to review the Asian markets. At 8:30 a.m. on July 21, wearing a pullover fleece and jeans, he convenes a daily morning conference call with clients. McCullough and Andrew Barber, his Asia expert, predict that Chinese equities, which had soared almost 76 percent during 2009, are headed for a correction.

One key reason: Short-term interest rates in Shanghai shot to 2.13 percent on July 21 from 1.21 percent on July 1 and pressed investors to liquidate holdings to meet margin calls. The Shanghai Stock Exchange Composite Index fell 16 percent from July 21 to Sept. 1.

“He’s pretty freewheeling in his opinions, but he’s a very good macro strategist, and he’s made great calls in this market,” says Ralph Reynolds, McCullough’s ex-boss at Carlyle and now co-founder of Bienville Capital Management LLC, a New York hedge fund firm.

‘In It to be Right’

McCullough jumped into analysis after managing long and short positions in consumer stocks as part of Carlyle’s $900 million Blue Wave hedge fund, which was launched in March 2007. By the third quarter of that year, the fund had dropped 9.3 percent mainly due to wrong-way bets on mortgages that didn’t involve McCullough. His stock portfolio was also declining in value, and that November, he and his six-member team were fired, he says.

McCullough, peeved by the episode, invested more than $1 million of his own wealth to form Research Edge and challenge the big banks’ research machine.

“I wanted to show Wall Street what the best investment research process is,” he says. “I’m not in this to generate trade flow or a banking deal. I’m in it to be right. I want to build something that will last.”

McCullough and his fellow independents have a long way to go before they can shake loose the big banks’ domination of the research game. If they make good calls, they may survive and even thrive.

“There will always be an opportunity for those who can make other people money,” Luther King’s Purvis says.

That’s the one unshakable truth on Wall Street.

To contact the reporter on this story: Edward Robinson in San Francisco atedrobinson@bloomberg.net

Last Updated: October 9, 2009 00:00 EDT

SO CLOSE!!!!!!

AUSSIE DOLLAR NEAR A HIGH

Of course the typical knee-jerk reaction is that the AUD is headed higher on the rate hike.
I suspect just the opposite, as deflation slowly takes grip and the deleveraging follows suit a drop in commodity prices should see a swift move to the downside in the AUD.

HOME BUILDERS & CONSTRUCTION

Looking at these charts they have a distinctively bearish appearance. There is not yet a clear 5 waves down and that is because I think we have witnessed a series of 1-2's.

PRIVATEER

Reading today the Privateer published over the weekend I remain bearish. The one thing I came to realize some time ago is that one cannot trade according to Austrian Economics. At best it acts as an economic moral compass and most certainly is a logical starting point.

BULLS EYE RESISTANCE

This chart of Westfield hit the 38.2% Fibonacci mark with a bulls eye. Secondly there is a GANN line that caught the 4^th quarter 08 bounce spot on. There is another GANN line which corresponds with a Fibonacci line just above where the bulls eye hit (I am hoping that was close enough) and lastly there is a Fibonacci Arc that has only been pierced for a day at the bulls eye.

Sticking to my Guns

The reversal last night still gives me confidence for my Uber bearish wave count. Surprises on the downside.

6's & 7's

On reading the blogs today even ardent EW bears are favouring a new recovery high.

One thing I learnt when there is a change in trend it comes from nowhere.

I am holding out for a strong down day today, which will place the bears at 6’s and 7’s.

 

I think this surprise rally is needed to create a 3^rd of a 3^rd wave to the downside.

 

BEARISH COUNT

If I take a bearish look at this chart I can count a 3rd of a 3rd of a 3rd.
Expect Fireworks

FEELINGS

The subject of Behavioural Finance is becoming extremely well known in finance and investing circles; however, there remains a common misconception as to the role feelings play in our investment decision making process. Superficially it appears that our feelings cause us to make irrational decisions in situations of uncertainty and therefore the best cure for our attack on our feelings bias’s is to cut them out completely. Until recent advancements in neuroscience this mistaken assumption would have been acceptable thinking; going forward far more comprehensive models will be required to outsmart our own smarts.

Allow me to take you on a journey of philosophical thinking before providing you with some scientific proof. Importantly these ideas and a lot of the words have been taken from an excellent book by neuroscientist Jonah Lehrer called, The Decisive Moment.

The question of how we make decisions has been puzzling philosophers throughout the ages. Plato was one of the 1^st to tackle the subject and used the now famous analogy of a charioteer being pulled by 2 horses. The charioteer being the rational brain and one horse representing good and the other bad combining to represent our feelings. Plato wrote of the bad horse, ‘He is of an ignoble breed. He has a short bull-neck, a pug nose, black skin, and bloodshot white eyes; companion to wild boasts and indecency, he is shaggy around the ears – deaf as a post – and just barely yields to horsewhip and goad combined’.  What Plato was putting across is that the human job as charioteer is to keep going forward by keeping both horses under control and in so doing he pioneered the thought of the mind being separated into 2 spheres; reason and emotion as became accepted by western culture.

René Descartes a leader of the Enlightenment era took a similar view and separated man into a soul representing the reasoning part of man, and a body full of ‘mechanical passions’. His objective was to advance man as an entity that could triumph reason over emotion, with the Cartersian faith forming the basis of modern philosophy. Francis Bacon and Auguste Comte took this rational approach to society further as did Thomas Jefferson with his hope for America been governed by reason alone. Immanuel Kant took it a step further with the imperative that morality was rationality. Freud to embraced Plato’s style of thinking by describing the mind as divided into a series of conflicting parts (id, ego) with the survival of modern society incumbent on man sacrificing the id (pleasure principle) for the sake of greater good.

Then with the increasingly scientific approach of mapping the cortex of the brain modern science became uncomfortable with a lot of the theory surrounding human thought. It lead to the belief that the mind behaved like a computer and therefore scientists such as Marvin Minsky (the pioneer of artificial intelligence) thought the programming of computers could replicate the human mind as one driven by rational thought. Cognitive psychologists followed this line of rational thinking taking it through to the field of our interest Behavioural Finance.

To summarize; the line of thinking Plato and his followers supported was a utopia whereby man could use his reasoning sphere of the mind to completely shut out the emotional side, which after all was the cause of all mistakes throughout the ages. As Lehrer in his book puts it, ‘the truth is far more interesting’. Science proves to us that in fact both sides are mutually dependent upon each other and without emotions reason wouldn’t exist at all. Talk about turning accepted philosophy on its head. In the story that follows Lehrer presents a case study where we learn how important emotions are in our decision making process.

In 1982, a patient named Elliot walked into the office of neurologist Antonio Damasio. A few months earlier, a small tumor had been cut out of Elliot’s cortex, near the frontal lobe of his brain. Before surgery Elliot had been a model father and husband and held an important management job. But the operation changed everything. Although Elliot’s IQ stayed the same he now exhibited one psychological flaw: he was incapable of making a decision. This made normal life impossible, routine tasks that would take minutes now took hours, with endless deliberation over irrelevant details. Damasio realized while in conversation with Elliot and later confirmed it with scientific brain testing that Elliot no longer had feelings.

At that time neuroscience believed human emotions were irrational and therefore not having feelings should make for better decisions. ‘The charioteer should have complete control’. What we now know is that a brain that cannot feel cannot make up its mind.

To bring some closure to this journey it is worth understanding how the emotional brain system works according to neuroscience. ‘The orbitofrontal cortex (OFC) is responsible for integrating visceral emotions into the decision-making process. It connects the feelings generated by the primitive brain – areas like the brain stem and the amygdala, which is in the limbic system – to the stream of conscious thought’. To say this in English the brain only feels comfortable making decisions when it experiences positive stimuli along with its rational calculations. The field of neuroscience is scientifically able to demonstrate how certain stimuli trigger emotions and their involvement in brain computation making the field of Behavioural Finance and Neuroscience mutually dependent on one another.


I would therefore like to suggest that in order to advance our ability to make decisions under uncertainty a two pronged approach is necessary, i.e. the study of our behavioural biases along with the influence neuroscience has to offer. To negate feelings just because we are scared of the biases they may represent is a one dimensional approach to the teachings of Behavioural Finance and is perhaps a misdirected objective - much like the philosophy taught by Plato and his followers.

NEW SOFTWARE

I am just trying out an interesting piece of new software

EWI and their 2000 HIGH

It still doesn't sit well the count that EWI have as their all time high in the Blue Chip Indices, i.e. 2000 the top with the 2003 bottom as wave A and 2007 as the wave B high, if this is the case one would then need to label the 2009 March low as wave C; I just don't get how they have labelled it only Primary wave 1 of C.

I need to check this again, but I have time as we are so overbought that we are due a proper correction. Also so far we have only had an ABC so perhaps there is a more complex correction at play.

Who knows, I am tired and now it is time to get some shut eye. This same problem doesn't exist thankfully in my markets, at least not the way I am counting from the 2007 high.

Paul Macrae Montgomery

I have only recently been reading some of his work, the man is a genius. I am not sure how his trading performance stacks up but the guy can sure write.

ANGRY

Today I felt angry with the markets as the whole process is actually quite ridiculous. In hindsight I should have expected more positiveness to come from the stimulus, even if it was just a band aid.

ANECDOTE

I am starting to pickup a lot of anecdotal nervousness from retail money. Questions like I think it is time to cash in. This rally is nuts is also what I am hearing.

MONTH END

I hate trading on month end it is a lottery and I don't like gambling.

STILL NO ANSWERS

Unfortunately we still cannot tell whether the top is definitively in. Month end today so there is always the chance for window dressing.

Still not Sure the Top is in

 reiterating my comments on the chart.

A CATALYST

Ran into someone today who proceeded to explain to me how the markets work.

He said along with many others one of the most annoying things to a reverse causality believer. He said to me that the market will only turn on the back of a catalyst. Something must trigger the reversal.

Markets simply reverse direction due to exhaustion of the underlying trend. The reason could be from a myriad of different sources the point is simply that more buyers or sellers dominate the previous trend.

I know I can do better in terms of explaining this but I simply had to place on record my disagreement that there has to be a catalyst. A catalyst is what so called experts assign to a reversal after the event, it is amazing that none of them seem to anticipate the catalyst in advance although one is able to make probabilistic forecasts on future direction.

MISTAKE

Last night I probably made a mistake buy closing out the 15 IYR 44 calls I had for Oct. I should have rather sold 46 calls or something like that as the market direction today is a 50:50 probability based on the wave count.

I suppose that is what happens when you wake up at 3am to trade after an exhausting day without fully rehearsing a game plan